When it comes to any financial market, one of the most important steps any trader has to take is analyzing the market. The aim of all analysis is to make predictions about the market. Wouldn’t it be nice to know exactly what is going to happen to prices? To know when to buy and when to sell with certainty? Well, that is kind of what technical analysis will help you to do.
Technical analysis is the most prevalent and common form of analysis. It is used in almost all financial markets, including the foreign exchange market.
The raw data that is used in technical analysis comes directly from the market. That is opposed to some other forms of analysis which take their raw data from other sources. But more on that later. Let’s dive deep into technical analysis.
What Is the Meaning of Technical Analysis?
As we have just mentioned, technical analysis is the most common form of analysis in all financial markets. In this form of analysis, a trader or investor would look at the data that is taken from the recent movements of price in the market and then analyze them to try to find patterns in them. Then these patterns are taken to see what is the possibility of their being repeated in the future.
The raw data that is fed into technical analysis is not simply price. It can also include other forms of market data. Basically, it can be anything that is related to trading and trading activities. So for instance trading volume can also play an important role in technical analysis.
But at the same time, the most important piece of raw data in technical analysis is the price movements. Now we said, recent price movements. But how recent?
It doesn’t have to be literally recent. The keyword here is basically the past. So based on the specific form of technical analysis that is being carried out, you can choose your time frame and see just how far back you ought to go. So this recent, can be literally recent or months and years into the past performance of an asset and its price movement.
The most important reason why technical analysis would be implemented is to try and identify possible patterns in the market. But identification of patterns is only the first step in the process.
The real part of the whole analysis is to try and see or rather calculate the probability of these patterns being repeated in the future. That is when the analysis pays off.
You want to find signals to enter into positions. Signals that are reliable and dependable. You enter into them and then based on the pattern that you had already figured out, your position pays off and then you exist again based on the previous calculations based on technical analysis.
The Way Technical Analysis Functions
The way technical analysis can work is that traders and investors take trading activities and use them to see whether you can find out data relevant to the market. Data that is related to supply and demand. In other words, data that is also relevant to buying and selling that has taken place.
As we have also mentioned above, technical analysis is the closest type of analysis that is carried out with the data directly derived from the market. And the whole point is to try and make sense out of the price movements, trading volume, all the volatilities, ups and downs, and changes that occur in the market.
You try to make sense through technical analysis to find signals. The signals that are derived from technical analysis can vary quite extensively. Some of them are for entering. Some of them are for stopping. And each single one of them can be about a certain form and strategy of trading.
The time frame to which these signals can apply also vary. They can be short term for the market right now and as it is in its current condition. Or it can even be for the long term and the future of the market.
How to Apply Technical Analysis in Trading
First of all, when it comes to using technical analysis, you need to know that there are basically no limitations with regard to the market or financial instrument to which you’re applying technical analysis. It can be used to analyze any market – be it the stock market, commodities, bonds, options, crypto, or the forex market.
In addition, traders would not normally use technical analysis and depend on it wholeheartedly!
The application of technical analysis to the market in which you are trading must be done with caution and careful calculation. First of all, technical analysis ought to be used along with other forms of analysis. Plus, one form of technical analysis should not be used on its own. Because that would decrease the reliability of the results.
What Are Indicators in Technical Analysis?
Perhaps you may have heard the term indicator more than technical analysis itself. But is there a relationship between them? There sure is.
Indicators are basically the tools that are used in technical analysis. They go hand in hand with each other. These indicators would allow you to analyze price movements and actually obtain the signal.
There are literally hundreds and hundreds of different technical indicators.
The Philosophy Behind Technical Analysis
There is one crucial philosophy or rather assumption that creates the whole basis of technical analysis. And that is the fact that traders will assume that patterns do indeed exist in the market.
There is a philosophy among economists and market experts that the idea of “market” itself is a notion that is absolutely not predictable. They believe that nobody can predict anything in any market at all.
There is truth to their belief. But no altogether.
The opposing view would be that of technical analysis. In this philosophy with regard to the notion of market, there is the strong assumption that not only patterns exist in the market and that they can be detected, but also that these patterns will repeat themselves in the future.
Other Forms of Analysis
There are countless other forms of analysis in financial markets. But the most prominent form of analysis that stands almost the other side of the analysis coin with technical analysis is called fundamental analysis.
While in technical analysis we take the raw data for analysis directly from the market or even directly from the chart itself, in fundamental analysis the raw analysis data are not taken from the market, but rather from the economy as a whole.
Therefore, in fundamental analysis, important economic factors such as inflation or interest rate are taken into account to predict what will happen to the market in the future.
Technical analysis is the most prevalent form of market analysis for any form of financial instrument, including foreign currency pairs in the forex market. In this form of analysis, data related to trading activity, such as trading volume and price changes, are taken into account to find out signals for entry and exit for future positions.